Fair Value of Financial Instruments

GAAP requires disclosure of fair value information about financial instruments, whether or not recognized in the Consolidated Balance Sheets, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rates and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparisons to independent markets and, in many cases, could not be realized in immediate settlement of the instrument.

Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent limitations in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates presented herein are not necessarily indicative of the amounts the Company could have realized in a sales transaction. The estimated fair value amounts have been measured as of the respective period-ends, and have not been reevaluated or updated for purposes of these consolidated financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each period-end.

The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk.

The carrying values, fair values and placement in the fair value hierarchy of the Company's financial instruments at June 30, 2019 and December 31, 2018 were as follows:



	June 30, 2019
	Carrying Value		Fair Value		Level 1		Level 2		Level 3
	(In thousands)
Financial Assets:
Cash and due from banks	$	75,647	$	75,647	$	75,647	$	—	$	—
Federal funds sold	3,237		3,237		3,237		—		—
Marketable equity securities	2,090		2,090		2,090		—		—
Available for sale securities	93,017		93,017		13,986		79,031		—
Held to maturity securities	21,318		23,111		—		1,085		22,026
Loans receivable, net	1,551,620		1,558,609		—		—		1,558,609
Other real estate owned	1,217		1,217		—		—		1,217
Accrued interest receivable	6,165		6,165		—		6,165		—
FHLB stock	7,475		7,475		—		7,475		—
Servicing asset, net of valuation allowance	844		844		—		—		844
Derivative asset	1,987		1,987		—		1,987		—

Financial Liabilities:
Noninterest bearing deposits	$	161,704	$	161,704	$	—	$	161,704	$	—
NOW and money market	502,178		502,178		—		502,178		—
Savings	174,319		174,319		—		174,319		—
Time deposits	639,530		643,354		—		—		643,354
Accrued interest payable	1,895		1,895		—		1,895		—
Advances from the FHLB	150,000		149,951		—		—		149,951
Subordinated debentures	25,181		25,106		—		—		25,106
Servicing liability	68		68		—		—		68
Derivative liability	11,603		11,603		—		11,603		—



	December 31, 2018
	Carrying Value		Fair Value		Level 1		Level 2		Level 3
	(In thousands)
Financial Assets:
Cash and due from banks	$	75,411	$	75,411	$	75,411	$	—	$	—
Federal funds sold	2,701		2,701		2,701		—		—
Marketable equity securities	2,009		2,009		2,009		—		—
Available for sale securities	93,154		93,154		9,798		83,356		—
Held to maturity securities	21,421		21,988		—		1,098		20,890
Loans receivable, net	1,586,775		1,584,858		—		—		1,584,858
Accrued interest receivable	6,375		6,375		—		6,375		—
FHLB stock	8,110		8,110		—		8,110		—
Servicing asset, net of valuation allowance	870		870		—		—		870
Derivative asset	2,867		2,867		—		2,867		—

Financial Liabilities:
Noninterest bearing deposits	$	173,198	$	173,198	$	—	$	173,198	$	—
NOW and money market	533,837		533,837		—		533,837		—
Savings	180,487		180,487		—		180,487		—
Time deposits	614,722		616,973		—		—		616,973
Accrued interest payable	1,381		1,381		—		1,381		—
Advances from the FHLB	160,000		159,753		—		—		159,753
Subordinated debentures	25,155		24,211		—		—		24,211
Servicing liability	73		73		—		—		73
Derivative liability	2,437		2,437		—		2,437		—

The following methods and assumptions were used by management in estimating the fair value of its financial instruments:

Cash and due from banks, federal funds sold, accrued interest receivable and accrued interest payable: The carrying amount is a reasonable estimate of fair value.

Marketable equity securities, available for sale securities and held to maturity securities: Fair values are based on quoted market prices or dealer quotes, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. The majority of the available for sale securities are considered to be Level 2 as other observable inputs are utilized, such as quoted prices for similar securities. Level 1 investment securities include investments in U.S. treasury notes and in marketable equity securities for which a quoted price is readily available. Level 3 held to maturity securities represent private placement municipal housing authority bonds for which no quoted market price is available. The fair value for these securities is estimated using a discounted cash flow model, using discount rates ranging from 4.0% to 4.3% as of June 30, 2019 and 4.7% to 5.1% as of December 31, 2018. These securities are CRA eligible investments.

FHLB stock: The carrying value of FHLB stock approximates fair value based on the most recent redemption provisions of the FHLB.

Loans receivable: For variable rate loans which reprice frequently and have no significant change in credit risk, fair values are based on carrying values. The fair value of fixed rate loans are estimated by discounting the future cash flows using the rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The fair value methodology includes prepayment, default and loss severity assumptions applied by the type of loan. The fair value estimate of the loans includes an expected credit loss.

Other real estate owned: Fair values are generally determined based on third party appraisals which may be adjusted based on age of appraisal or market conditions identified while preparing the property to be listed for sale through broker quotes or otherwise. Appraisals are based on observable market data such as comparable sales, however, adjustments made to third party appraisals, for the age of the appraisal or market conditions identified while preparing the property to be listed for sale through broker quotes or otherwise are unobservable and therefore these assets are classified as Level 3 within the valuation hierarchy.

Derivative asset (liability): The valuation of the Company’s interest rate swaps is obtained from a third-party pricing service and is determined using a discounted cash flow analysis on the expected cash flows of each derivative. The pricing analysis is based on observable inputs for the contractual terms of the derivatives, including the period to maturity and interest rate curves. The Company also considers the creditworthiness of each counterparty for assets and the creditworthiness of the Company for liabilities.

Servicing asset (liability): Servicing assets and liabilities do not trade in an active, open market with readily observable prices. The Company estimates the fair value of servicing assets and liabilities using discounted cash flow models, incorporating numerous assumptions from the perspective of a market participant, including market discount rates.

Deposits: The fair value of demand deposits, regular savings and certain money market deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposit and other time deposits is estimated using a discounted cash flow calculation that applies interest rates currently being offered for deposits of similar remaining maturities to a schedule of aggregated expected maturities on such deposits.

Borrowings and Subordinated Debentures: The fair value of the Company’s borrowings and subordinated debentures is estimated using a discounted cash flow calculation that applies discount rates currently offered based on similar maturities. The Company also considers its own creditworthiness in determining the fair value of its borrowings and subordinated debt. Contractual cash flows for the subordinated debt are reduced based on the estimated rates of default, the severity of losses to be incurred on a default, and the rates at which the subordinated debt is expected to prepay after the call date.

Off-balance-sheet instruments: Loan commitments on which the committed interest rate is less than the current market rate are insignificant at June 30, 2019 and December 31, 2018.